Lightpath Technologies Inc Q4 FY2020 Earnings Call

Good afternoon, and welcome to the LightPath Technologies Fiscal Fourth Quarter and Year-End 2020 Financial Results Conference Call. All participants will be in a listen-only mode. Please also note today’s event is being recorded. I will now pass the call off to Donald Retreage, Chief Financial Officer of LightPath Technologies. Please go ahead.

Good afternoon. Before we get started, I would like to remind you that during the course of this conference call, the company will be making a number of forward-looking statements that are based on current expectations and involve various risks and uncertainties that are discussed in this periodic SEC filings. Although the company believes that the assumptions underlying these statements are reasonable, any of them can prove to be inaccurate and there can be no assurance that the results will be realized. In addition, references may be made to certain non-generally accepted accounting principles or non-GAAP measures, for which you should refer to the appropriate disclaimers and reconciliations in the company's SEC filings and press releases. Following management discussions, there will be a formal Q&A session open to participants on the call. I now would like to turn the conference over to Sam Rubin, LightPath's President and Chief Executive Officer. Sam, please go ahead.

Thank you and good afternoon. Welcome to LightPath Technologies fiscal 2020 fourth quarter financial results conference call. Our financial results press release was issued after market closed today and posted to our corporate website. Following my remarks, our CFO, Donald Retreage will further review our financial results and provide more perspective on key areas. We will then conduct a Q&A session. Now, onto my remarks. Our fiscal 2020 fourth quarter and full year results reflect a consistent and continuing improvement and growth of our business, while at the same time navigating the dynamic and changing conditions caused by the effects of COVID-19. Classified as an essential business, we remained open and operating to the extent possible. We continued to take all precautions to ensure that our employees remain safe and that our business operations continue. Through the fall, we are very encouraged to have ended the year by delivering growth in revenue, backlog, gross margin, gross profit, net income, EBITDA, and cash balance, while reducing our total debt and financial lease balance and improving our cost structure with a reduction in operating expenses. All of this was achieved despite nearly six months of the fiscal year being impacted by COVID-19. Similar to our results in the previous quarters, our fourth quarter results continued to show consistent improvement year-over-year and consistent results throughout our fiscal year. The gross margin for the quarter ended at 39%, up from 32% in Q4, 2019, while the EBITDA margin grew to 19%, up from negative 3% the same period the previous year. These results reflect savings from the integration of the ISP acquisition and other efficiency-related activities, as well as the favorable product mix in our PMO business. Additionally, our backlog grew to $19.1 million, up from $17.1 million at the end of fiscal 2019, but down from $20 million the previous quarter. The sequential decline in backlog is attributed primarily to the annual blanket order from our largest customer, which typically is renewed in our fiscal second quarter ended December 31. While the 4% growth in revenue year-over-year is definitely a positive outcome, our actual shipments during the quarter were lower compared to plan due to unexpected rescheduling requests by some customers as a consequence of the impact of COVID-19. As we have mentioned in earlier communications over the last few months, we have been capacity constrained in some parts of our business since February primarily due to the demand from 5G infrastructure development deployment, a trend that we see continuing. We have been addressing those capacity constraints through the use of overtime through acceleration of investments in production equipment and through careful scheduling and planning of our production capacity. However, due to COVID-19, some customers have experienced either fluctuating demand or some unexpected impacts to operations or other parts of the supply chain. Given the nature of the manufacturing process and added complexity of being capacity constrained, our manufacturing schedule cannot always adjust fast enough to such unexpected changes, leading to temporary increases in our inventory as seen in our inventory levels growing to $8.9 million. While we strive to be agile and adjust quickly to changes in demand, we expect for some of these variations to continue in the coming months until demand and supply chain return to a steady state. In parallel to navigating the COVID-19 impacted economy and supply chain, our team has worked on developing a new strategic direction for LightPath that was initiated following my appointment as CEO in March 2020. This strategy is based on our strengths and core capabilities to address the largest and fastest-growing trend in our industry for visible and infrared optics. I’d now like to discuss some key elements of this strategy. First, we are going to support the diversified photonics market. We're going to lead the efforts to capitalize on optics as an enabling technology. We recognize that the opportunity for optics and optical assemblies has changed over the past several years. Now, optics, or more generally photonics and optical technologies, are increasingly pervasive across industries and markets. Optics is not an industry vertical in itself, but the enabling technology that spans industries well beyond telecommunication, for which we are seemingly known. Optics are the key technology in industries from automotive, defense, medical, surveillance, industrial equipment, telecommunications, and consumer products, just to name a few, all of which are industries we already serve. As such, the market opportunity for what we do at LightPath is enormous and global, and is constantly expanding as other industries and companies find applications for optics in their products. Second, we'll focus on our competitive anchors, including our differentiated design capabilities, molding IP, the loyalty of manufacturing technologies, and low-cost vertically integrated global manufacturing. We will prioritize our efforts around the differentiation we bring to the markets and our customers that others cannot offer. And we will constantly seek to add to those capabilities as needed. Third, we will be centered around continuous improvement through operational excellence leading to margin and profitability optimization and strengthening of our overall financial position. This will encompass both short-term and long-term initiatives throughout the organization and be supported by a culture which values results and accountability. Fourth, we will make investments that improve capacity and factory floor efficiency, engineering expertise, and leverage our human capital. We will make the necessary investments in our people to enable our strategy with world-class optical design and engineering talent, including a salesforce that can focus and prioritize customer opportunities that support our strategic goals. Finally, and perhaps the most important strategic directive is to mobilize around the integrated solutions orientation for high-value customers. In doing so, we will leverage our expertise to focus on client's opportunities that align with our new strategic direction and ultimately improve our financial performance. We will leverage our unique capability using our expertise in optical design and manufacturing to create solutions for customers rather than components. Over time, this will promote a richer business model supported by longer-term partnerships with our customers. In the coming weeks, we will begin a comprehensive alignment of the organization to our new strategic direction, including a review of our capabilities, structure, processes, and all other aspects required by our team to be positioned to execute on this direction. Some of those opportunities for improvement and operational excellence have already been identified shortly after I joined the company and we began executing upon them immediately. One such area, for example, includes our cash management, where through implementation of lesser processes and controls, we have been able to increase our cash position to $5.4 million while continuing to invest in capacity expansion and utilizing our line of credit for financial flexibility, and reducing our total debt and operating lease obligations. Strategic priorities evolve, and this is the beginning of the process. LightPath will change the operations and execution culture to be best-in-class, and we will choose the highest value customers and business opportunities to invest in. The enhanced approach will provide even more value to our customers, greater opportunities to our employees, and better financial returns to our shareholders. As we continue to implement operational improvements throughout our organization and fully execute on the outcomes of our comprehensive strategic review, we expect both near-term and long-term impacts towards further improving upon our growth and key financial indicators beyond what we have achieved to date. Now, I'll pass the call over to our CFO Donald Retreage to provide more details on some of the other aspects of our fourth quarter and full year 2020 financial results. Donald?

Thank you, Sam. First, I would like to mention and remind everyone that much of the information we're discussing during this call is also included in the press release issued earlier today and in our 10-K filed with the SEC. I encourage you to visit our website at lightpath.com, specifically the section titled “Investor Relations.” Now on to my remarks pertaining to the fourth quarter and year-end fiscal 2020. Sam's remarks covered some of our financial performance along with key elements of our strategic direction, so I will specifically discuss key financial areas. Revenue for the first quarter of fiscal 2020 was approximately $9.1 million, up from $8.7 million in both the third quarter and fourth quarter 2019. For the year, revenues were $35 million, up from $33.7 million in fiscal 2019. IR product revenue was $4.8 million in Q4 2020 or 53% of total revenue, up from $4.3 million or 50% in the third quarter 2020 and $4.7 million, or 54% of the total in the prior period. Visible precision molded optics, or PMO products revenue in fourth quarter 2020 was $3.9 million or 43% of the total, same as third quarter 2020 or 44% of the total in third quarter 2020 and $3.5 million or 40% of the total in the fourth quarter 2019. For the year, IR product revenues were $18.1 million or 52% of the total, up 5% from about $17.2 million, or 51% of the total in fiscal 2019. PMO revenues were $14.6 million or 42% of the total in fiscal 2020 and up 4% from about $14 million or 42% of the total in the prior year. The demands for our revenue in the fourth quarter and full year in respective periods were from specialty products and non-recurring engineering products, which varied greatly from quarter-to-quarter, and were substantially smaller contributors to the consolidated revenue. With respect to our margin profile, generally speaking, PMO products are small and almost entirely molded, so we have faster turnaround times, higher volume applications, and more automated processing. These products are also generally low in price. We historically have had margins averaging in the 40% to 50% range. This group represents about 42% of our total revenue in fiscal 2020. You can see that of the two primary segments, PMO is a small group but with the higher margin. The IR product group represents a larger and faster-growing market opportunity. IR margins have historically been in the 20% to 35% range, with new molded IR lenses which use our proprietary internally developed BD6 material being able to achieve higher efficiencies. As part of our gross margin improvement strategies, we have been aggressively working on marketing new products and targeting new customers using a line of innovative BD6 while attempting to convert existing customers to the extent possible from using our germanium lenses to our BD6 lenses. Moving on, gross margin in the fourth quarter of fiscal 2020 was $3.5 million, an increase of 24% as compared to approximately $2.8 million in the same quarter of the prior fiscal year. Total cost of sales was $5.6 million for the fourth quarter 2020, down from $5.9 million in the prior year. The lower total cost of sales is significant when you consider that total sales increased by 4%. Gross margin as a percentage of revenue was 39% for the fourth quarter 2020 as compared to 32% in the fourth quarter 2019. The increase in gross margin as a percentage of revenue is primarily driven by an increase in sales and an improved cost structure, along with the elimination of elevated costs, including labor, manufacturing inefficiencies, and increased overhead expenses associated with the relocation of our New York facility in the prior year period. For the year, gross margin for fiscal 2020 was $13.8 million, an increase of 11% from $12.5 million in fiscal 2019. The total cost of sales was approximately $21.1 million in fiscal 2020, slightly lower than $21.2 million in the prior year. Gross margin as a percentage of revenue was 40% for 2020 compared to 37% for fiscal 2019. The increase in gross margin reflects changes to our cost structure, as well as improvements made in the second, third, and fourth quarters of fiscal 2020 after several factors negatively impacted the first quarter of fiscal 2020. As in the fiscal third quarter, demand in aggregate has been strong, although there are pockets of weakness that emerged as a result of COVID-19, which includes, as Sam mentioned, the delivery and processing challenges. We continue to enjoy strong demand from secular or long-term market applications including 5G. For this product, we believe we could have had a larger order flow if we had not been capacity constrained. Additional capacity has been added, and we're accelerating certain build-ups. Our production volumes are growing. In the fourth quarter 2020, we produced 1.2 million lenses up from 904,000 lenses in Q3 of 2020, and 868,000 lenses made in second quarter 2020. Unit volume sold in the fourth quarter of 2020 was up 62% as compared to the fourth quarter of fiscal 2019 and up 41% year-on-year. Total units sold in the fourth quarter was 3.6 million, up from 2.6 million last year. During the fourth quarter of fiscal 2020, total operating expenses were approximately $2.9 million, a decrease of $1 million, or nearly 26% as compared to $3.9 million in the same period of the prior fiscal year. The largest reduction came from SG&A, which decreased from about $900,000, and new product developments which decreased by about $117,000. The change from the prior year reflects the elimination of non-recurring expenses from last year, which are related to the relocation of the New York facility, as well as other reduced personnel and overhead costs from synergies, and to a lesser extent limited travel and marketing expenses from COVID-19 restrictions. The product development expense variation reflects shifting in personnel of the newly created product management function, which is also in our selling, general and administrative expenses. For the full year, total operating expenses in 2020 were $11.7 million, down $2 million or about 15% from $13.7 million in 2019. SG&A was down $1.5 million and product development expenses were down $300,000 for reasons similar to the changes in the fourth quarter. It should also be noted that expenses in the third quarter were reduced by gains on the disposal of equipment of approximately $136,000, which masks some of the savings when compared to total 2020 expenses. Our consolidated corporate income tax in the U.S. is shielded by our net operating loss carryforward benefits of approximately $74 million at June 30, 2020. However, we do have to pay income tax to the countries of certain foreign subsidiaries. Income tax expense for the fourth quarter of fiscal 2020 included the reversal of $406,000 of income tax benefits recorded in the first half of fiscal 2019 due to the change in the company's estimated utilization of U.S. net operating loss carryforward benefits for 2019. During the fourth quarter of fiscal 2020, the company recorded income tax expense of $90,000 as compared to $496,000 in the same period of the prior fiscal year. During fiscal 2020, the company recorded income tax expenses of $764,000, primarily related to the income tax from operations in China and the Chinese withholding tax associated with the intercompany dividend. With higher revenues, strong margins, management of expenses, and lower income tax, net income for the fourth quarter of fiscal 2020 was $657,000 compared to a net loss of $1.8 million for the fourth quarter of fiscal 2019, which was negatively impacted by elevated costs, including labor costs, manufacturing inefficiencies, and increased overhead expenses associated with the relocation of the company's New York facilities. We’re operating far more efficiently and profitably having completed that transition, improved our cost structure, and increased revenue margins. Net income for the year was $867,000, up from a net loss of $2.7 million. Moving to the balance sheet and cash flow-related items, capital expenditures, including equipment financed through leases, were $938,000 in the fourth quarter 2020 and $2.4 million for the year, up from $326,000 and $2.5 million respectively in the prior periods. Given that we have been running at near capacity, we intend to continue to invest similarly in 2021. Meanwhile, net cash provided by operations was $3.7 million for fiscal 2020, up from $411,000 in the prior year, with fourth quarter 2020 contributing $1.8 million or about 49% of full year amounts. Total debt, including finance leases, was reduced by approximately $650,000 or 10% in fiscal 2020 from June 30, 2019. While the cash balance as of June 30, 2020, was $5.4 million, up from $4.6 million at June 30, 2019. As of June 30, 2020, LightPath’s 12-month backlog was $19.1 million, an increase of 11% from $17.1 million as of June 30, 2019. It should be noted that it is natural for backlog to fluctuate during the year as a result of the timing of such bookings of large orders and annual renewals. The company has also undisclosed backlog beyond 12 months. On a final note, through the increase of our share price and market value, we're pleased to have been added to the Russell Microcap Index with the annual reconstitution on June 29, 2020. With this review of our financial highlights and recent developments concluded, I will turn the call over to the operator so that we may begin with the question and answer session.

Thank you. We will now begin the question and answer session. Our first question comes from Marc Wiesenberger with B. Riley FBR. Please go ahead.

Yes, thank you. Good afternoon. Very nice execution in the quarter. Currently, I think you have capacity to produce around 3 million molded lenses per year. Can you talk about the growth trajectory around the molding capacity and where you'd expect to deploy that capacity from a geographic perspective?

Yes, our capacity has definitely been growing in the last few months as we've been investing in accelerating some of the investments in our manufacturing equipment. That reminds me, in the previous quarter I stated that we're going to expedite some of those investments which we have, and which have come into effect during the last quarter and towards the end of the quarter. That's evident in the growth of our molded lenses, where we produced 1.2 million in the last quarter, which is a 33% growth compared to the quarter before that. Some of the investments in those molding machines and equipment are in our China facility. Some of them are in the U.S. facility, and other parts of the investment as the targets of where we make those investments and where we need to expand capacity change over time. Some of those investments are going to be in our facility in Riga, as well as additional investments in the U.S.

Great, thank you. Can you talk a little bit more about the progress of BD6 adoption from new customers, substitution from existing customers? Your goals for BD6 and from your product portfolio and then the resulting financial implications we should see in FY 2021?

Definitely. The results from this transition to BD6 are very encouraging as we stand right now. By nature, the type of orders for BD6 versus germanium or altogether for thermal imaging, takes a long time to mature from design to prototyping to actual production. One example is a large contract that we announced a few months ago. We are only in the near future going to start shipping on that contract. That contract alone has taken quite a while to reach. We have a strong pipeline of opportunities, many in the design process in which we work very closely with the customer, and some of them in the prototyping process. We believe that we have some significant wins coming down the road. Most of them will start shipping within six months or so after we get the orders. Some may be shorter, some may be longer.

Sure. You talked about solid 5G demand from China. What other geographies are you seeing that are starting to accelerate and have deployments, and can you talk about these other markets outside of China?

Yes, we provide our 5G lenses to transceiver manufacturers and transponder manufacturers, most of whom are in Asia. By the nature of the supply chain, we do know that we supply lenses into multiple manufacturers of 5G equipment and optical transceivers in a variety that we know that we're definitely not concentrated in one country or another in terms of the deployment of 5G, as we do not have full information on geographical deployment.

Sure, understood. And then last one from me. I think you've talked about the emerging use cases for optics and photonics role requiring supplementary technologies. Can you talk about how LightPath is positioned to meet those additional demands? Thank you.

Absolutely. Part of the organization alignment that we're going to do is an ongoing effort over the next few years. We're going to continuously look at such opportunities and see what supplemental products or technologies we need in order to support them. This could be a situation where a customer buys our lens and then works with us on a complete solution. That solution might include a scanning mirror, which is the electronic component that moves the beam around. We could also be integrating the detector and aligning the entire optical system to deliver really a complete, closed optical system to the customer. Given the versatility of optics, the type of other components needed would vary from one customer to another. As we proceed, we're going to identify which makes sense for us, and where we can create real value for customers.

Great, thank you very much.

The next question is from Gene Inger with ingerletter.com. Please go ahead.

Hi, Sam and Don, congratulations on navigating through the pandemic so far and keeping the company constantly operating. Forgive my sore throat, but I'll try to ask a couple of questions that Marc didn't touch on. You basically covered as Sam by discussing or expanding beyond what some believe are relatively low-margin commodity lenses, although you've already increased the margins on those. So good job with that. You just mentioned integrated optics, which caused me to think of your colleagues and neighbors over at Luminar. I don't know that their going public affects you directly. But as they expand, do you foresee an expanded relationship or would you rather not talk about potential colleagues or customers?

Thank you, Gene. It's good to hear your voice, and thank you for the questions. First of all, I'll start by congratulating our neighbors Luminar for going public and joining us in the stock exchange. We have a good relationship with many customers, and we explore whatever value we can create for them. We do not comment on specific customers most of the time. However, we are looking closely at the LiDAR marketplace and work with multiple companies developing different light solutions at many levels. It's obvious that LiDAR is becoming a major application for optics in the future. We cannot predict which company will win the LiDAR race, so the best thing we can do is work with many companies and support them by creating value through our optical engineering expertise.

I also wanted to inquire regarding China. Your subsidiaries there are wholly owned. I think in the past, there was a large fund out of Shanghai that was an investor. I'm assuming that is now retired and the Chinese government does not have a problem with you operating as a wholly owned operation.

That's correct. Both companies are wholly owned by us 100%. We have 100% control of operations. We are not limited by any regulatory requirements related to our Chinese subsidiary, similar to the experience I had in the six years I spent in China setting up and building large companies there. A wholly-owned foreign entity is completely owned and controlled by a foreign company, and that's the case with LightPath's two subsidiaries.

I'm glad to hear that. Could you also expand? Lately there has been more tension between China and India. Companies like Paragon, which is Israeli with wireless backhaul, have benefited because they do a lot of business in India with Vodafone. I'm just wondering whether India, barring Huawei, because of the tensions between them, actually works to your benefit, with vertical integration in China. I assume much of what you make in China is sold to Huawei or other networking companies in the country?

Yes, we don't have much direct sales into India. As I mentioned in previous comments, we often don't know the end-use of our products, as we're sometimes two or three layers removed from the final product. We don't believe our business has been affected by that to our knowledge, so there hasn't been a notable impact.

I'm glad to hear that. And my last question would just be, Ciena’s CEO a couple of weeks back when they made their numbers for the second quarter gave pretty sloppy guidance going forward and he talked about many of their customers in photonics, specifically Lumentum, which I think you deal with. That may be what you're reflecting when you're saying your customers are rescheduling delivery. But it sounds like there are a lot of orders that aren't cancelled, but simply pushed into the future. So isn't that giving an impression, I hope that things are looking favorable as we adjust to the new normal and migrate into the third and fourth quarters?

Yes, we definitely meant that orders are being pushed out due to logistical constraints. For example, we have one customer that has production lines in three different facilities. If one facility closes down, the other two cannot pick up the entire capacity, which leads to delays in deliveries until that facility reopens. Most of those delays are similar in nature, caused by unexpected factors affecting the supply chain and operations. We're often asked to delay or hold off on shipments. If we receive enough notice, we can halt production and move that capacity to use for something else. If not, we hold it in inventory.

Well, it sounds promising. You had a good quarter, the EBITDA was great, and you managed this despite the impediments caused by the pandemic. Looking forward to good growth and welcoming your leadership, I hope things go well.

Thank you. I appreciate that, Gene. Have a good day.

Our next question is from Chris Witkowski, a private investor. Please go ahead.

Hello, good afternoon. Congratulations on a great quarter.

Thank you.

So, regarding the 5G visible optics molded lenses. I'm not sure if I parsed your statements correctly, but it seems like you're saying that there's pending demand even outside of your backlog. That is, if you tell your customers that they're holding back on some orders, if you tell them that you have more capacity, you'll get more orders. Is that correct?

Yes, you understood it correctly.

All right, that's great to hear. And about those lenses again, the 5G lenses. Now as data rates increase, the optics have to be more precise, and are you getting certain price increases on your lenses? Does that cause a bit of the increase in the gross margin? How is the pricing going?

Don, do you want to...

In general, yes. However, our formula in the past has been to give discounts on high volume orders for various reasons. Obviously now at full capacity, those levels have leveled out, so there won't be any great price decreases aside from what the market is demanding. Therefore, we do not foresee the pricing erosion of the PMO lenses to affect us significantly in the next two or three quarters.

All right. That's great to hear. And regarding your strategic realignment, should we be looking forward to noticeably higher SG&A costs because of that in the future?

Yes, that's a great question. We've been very disciplined in both our growth and expenses on new capabilities and manpower, as well as our capital investments where we need to maintain discipline to finance all of that, while being aware of profit margins or total EBITDA margins as we grow the business. We intend to continue that discipline, but we may occasionally need to add specific skills in the form of people or some unique equipment that might take a bit longer to see the return. However, we do not expect that to be significantly different.

All right, that's good to hear. It's about time we started making some real profits here. And another question. So about those temporary pushouts. Can you share what you're experiencing now in August and September? Are you less affected now than you were in the past quarter?

I’d say it’s still ongoing as I noted in my remarks. We believe it will continue to be somewhat ongoing until things stabilize. In most cases, the pushouts are shifting between different customers and not just one customer that keeps pushing out, except for maybe one or two cases. But for the most part, we see transitions occurring among different geographical areas where it happens, different customers in different industries and different periods. We try to be as agile as possible, but given that we are operating at capacity or at least facing capacity constraints, the delays can lead to a bit more inventory than we care for.

Okay, I understand that. Well, that's it for me. Thanks again and good luck.

Thank you.

Thank you.

We show no additional questions at this time, so I'd like to turn the conference back over to Mr. Rubin for any closing remarks.

Thank you for participating in today's call. Before we conclude, I wanted to thank Jim Gaynor, my predecessor, for the 13 years of service as the CEO of LightPath and extend our best wishes to Jim and his family on his retirement. We look forward to speaking with you next quarter. Until then, we will be participating at the Sidoti & Company Fall Virtual Investor Conference on September 23, and have been invited to speak at the MicroCap Club’s Virtual Leadership Summit on September 25. Thank you again, and goodbye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.